The credit outlook for rated Cypriot banks is stable, reflecting the ongoing restructuring of their domestic operations, their improving financial fundamentals and their continuing geographical diversification through their expansion overseas, says Moody’s Investors Service in its new banking system outlook report for Cyprus. However, this outlook is balanced by the banks’ raised credit risk profiles, arising from the rapid credit growth recorded over the past couple of years. «Cyprus banks have over the past two years intensified their efforts to expand their domestic market shares at the expense of the cooperative credit sector, strengthen their overall franchises and enlarge their overseas operations in their targeted markets. This activity was fueled by their realization that only those banks with critical mass, defensible domestic franchises and cost-efficient operations would be successful as Cyprus enters the eurozone,» says Constantinos Pittalis, a Moody’s vice president, senior analyst and co-author of the report. Having suffered heavily from weak credit following the collapse of the Cyprus Stock Exchange that led to a couple of loss-making years, the banks have undergone notable senior management changes that spearheaded major efforts to restructure their domestic operations to tackle their asset quality problems and restore their financial performance. To a large extent, the banks have succeeded in turning around their domestic operations by reducing the level of non-performing loans, increasing their earnings generating capacity and lowering the level of credit costs, leading to an overall improvement in their financial fundamentals. At the same time, the banks have been expanding their overseas operations, leading to higher revenues and risk diversification. The banks’ improving financial performance has attracted new shareholders, with the banks experiencing significant ownership changes that are generally forcing them to adopt more focused strategies that would lead to shareholder value creation, to become more transparent and to enhance their corporate governance structures. «In addition, the growing importance of Cyprus as an international business center is boosting significantly the financial performance of Cypriot banks. The increasing number of overseas companies registering in Cyprus, lured primarily by the low-tax regime, is leading to a significant increase in non-resident deposits and is boosting the banks’ profitability and efficiency indicators,» notes Melina Skouridou, a Moody’s senior associate and report co-author. Moody’s cautions that although the Cypriot banks have been reporting improved credit quality indicators, rapid credit expansion in this relatively mature banking system could lead to future asset quality problems. The strong growth in lending to the housing and construction sector needs to be monitored carefully in light of rising real estate prices in recent years. In this respect, Moody’s views positively the proactive stance of the central bank of Cyprus regarding real estate lending, reflecting the enhancements in the regulatory and supervisory environment following EU accession.